Banks again kept afloat but stormy waters will test them

ANALYSIS:The €35 billion package for the banks aims to reassure investors that protection can be increased if the need arises, writes
SIMON CARSWELL

THE LATEST bailout of the banks – the Government’s fourth attempt and the first with overseas state support – will build steeper levees around them but has not yet quantified how high the tide of bad loans will rise in stormier times.

The €35 billion package for the banks – out of a total rescue fund of €85 billion for the beleaguered Government and the drowning Irish lenders – aims to show international investors that the levees can be built higher still if needs be.

The bank fund is split into €10 billion for upfront recapitalisations and a €25 billion contingency fund which the banks can tap if loan losses surge beyond existing worst case scenarios.

This brings the latest bailout of the banking sector to €60 billion, with the potential for that to rise to €85 billion if the contingency fund is drawn on in full.

Sharing the banks losses with senior debt is off the table due to fears about the repercussions across the European banking system. However, it would appear that subordinated bondholders at AIB and Bank of Ireland will have to share the pain – following similar moves at Anglo Irish Bank and Irish Nationwide – through voluntary deals on debt buy-backs and swaps.

While the €10 billion initial bailout may ease market nerves, investors will want to know how soon the €25 billion contingency fund will be raided and whether it will be enough to keep the banks breathing as water levels rise.

Incredibly – at the fourth attempt to repair the banks – the lenders have been given another chance to raise capital on their own and the two biggest banks, Bank of Ireland and AIB, can again avoid outright nationalisation.

If they fail, the money will come from the €35 billion bailout fund.

AIB, Bank of Ireland and the Educational Building Society have until the end of February to raise funds to bring their capital ratios over 12 per cent – the new level expected internationally.

Irish Life and Permanent has a little longer – until the end of May – to allow the group to publish its annual results for 2010 so it can use them to tap shareholders.

AIB is unlikely to be able to build the higher buffers on its own – it simply has too much to raise.

The Central Bank wants the bank to raise a further €5.265 billion on top of the €4.5 billion it has failed to raise from the previous bailout target set in September.

The game is up for the bank. It is expected to fall into State hands, handing over a stake of more than 96 per cent as the Government swaps the required €9.765 billion for almost full ownership.

Trying to structure the capital injection in such a way to keep the State from owning 100 per cent of the bank is the challenge here.

Bank of Ireland – regarded as Ireland’s least worst bank – must raise €2.2 billion. The bank bullishly said last night that it would do this on its own by internal means and from existing shareholders.

The Government will underwrite the latest fundraising efforts and if the bank fails, State ownership will rise to more than 70 or even 80 per cent.

State-owned EBS must raise a further €438 million on top of the €525 million it still has to find.

US private equity investors led by Dublin firm Cardinal Capital Group may be the only source for this – beyond the State – so a sale to the group looks inevitable.

Irish Life Permanent, the only other bidder for EBS, has to raise a further €98 million on top of its earlier €145 million target so it may have enough on its plate.

Wind-down plans for Anglo Irish Bank and Irish Nationwide Building Society will be decided on by the end of January so these two black-hole lenders will not require recapitalisation. This latest bailout is to support viable banks.

To improve the viability of the four banks left standing, the Central Bank has directed them to plan for the sale of assets through full disposals or their sale to investors through securitisation deals to remove them off their books.

This will shrink their balance sheets, bringing their loans and deposits closer in line so they don’t have to rely on outside investors which no longer lend to them due to concerns about Ireland’s debts.

The banks must split their businesses into core and non-core, like Britain did with RBS and Lloyds. Detailed plans showing how they plan to shrink themselves must be provided by the end of April.

Some €2 billion of the upfront €10 billion for the banks will be used to help them sell these assets.

As part of the shrinking of the banks, the National Asset Management Agency will take a further €16 billion in loans, erasing all land and development loans at AIB and Bank of Ireland in a reversal on previous Government decisions, the most recent in September.

This will push Nama’s loan book to €89 billion, adding thousands more loans and developers.

To reassure the markets further, the Central Bank will seek external verification on its stress testing of the banks next March. Until then, investors will keep looking with trepidation at the waters beyond the banks’ buffers.